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Can Coal Stocks Add Value to Your Portfolio?

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In good times and in bad, the equity markets see flocks of investors coming in to invest their hard-earned money in the hope of good returns. Investing in stocks needs a certain appetite for risk, but taking positions in coal, which is showing a continuous downturn, is undoubtedly far more risky.

The coal industry has been severely impacted by stringent regulatory measures to control emissions in electric power generation. But notwithstanding the many hurdles in coal’s way at present, this fuel source still holds an advantageous position thanks to its wide availability and lower cost compared to other fossil fuels and renewable sources of energy.

Per a report from the World Coal Association, we currently have 861 billion tons of proven coal reserves worldwide. This means that there is enough coal to last nearly 112 years at current rates of production. In comparison to this, proven oil and gas reserves are equivalent to around 46 and 54 years, respectively, at current production levels. Proven reserves are considered economically recoverable at any given time, taking into account available mining technology and costs. As you can see, the current availability of coal even outpaces the combined proven reserves of oil and gas.

Yet regulatory measures like the Clean Power Plan will add to the mounting challenges of coal in the U.S. There has, however, been a temporary reprieve with the Supreme Court ruling in Feb 2016 to stay the implementation of the Clean Power Plan and blocking the efforts of the U.S. administration to lower global warming by regulating emissions from coal-fired power plants.

The crucial question is what’s keeping the coal industry afloat amid rising competition from other fuel sources and a hostile regulatory climate. Let’s dig a little deeper into the factors driving this industry going forward.

Coal Dominates U.S. Power Generation: Coal as a major source of generating fuel dominates the utility industry. Per the Energy Information Administration (EIA), coal was the generating fuel for nearly 34% of the electricity consumed in the U.S. in 2015. Moreover, electricity generation absorbs more than 90% of the total U.S. coal consumption. The reason is quite simple: coal is by far the least expensive and most abundant fossil fuel in the country.

The EIA forecasts that coal usage for electricity generation will decline in 2016 from 2015 levels. However, the EIA also predicts coal usage will increase by 27 MMst or 4% in 2017 from 2016 levels, thanks to rising natural gas prices and increase in electricity generation.

Long-term Supply Agreements: Most of the coal companies in the business have existing long-term coal supply agreements with their customers. Coal producers are also prompt about renewing contracts on expiry as these provide earnings visibility into the future.

The marketing team of Westmoreland Coal Co. WLB continues to work with its major customers for renewal of long-term contracts and was quite optimistic on the same. These contract renewals will lend support during this prolonged period of crisis.

Not Just Electricity Generation: Electricity generation is just one use of coal in the U.S. Manufacturing plants and industries use coal to make chemicals, cement, paper, ceramics and metal products, to name a few. Methanol and ethylene, which can be made from coal gas, are used to make products such as plastics, medicines, fertilizers and tar.

Certain industries consume large amounts of coal. For example, concrete and paper companies burn coal, and the steel industry uses coke and coal by-products to make steel for bridges, buildings and automobiles.

Coal as Input for Steel Industry: Due to its heat-producing feature, hard coal (metallurgical or coking coal) forms a key ingredient in the production of steel. Nearly 70% of global steel production depends on coal. Since met coal is an essential ingredient for the production of steel, U.S. met coal producers could benefit from the increase in steel consumption.

Although the steel industry is expected to remain under pressure for some time, it is certainly expected to grow thereafter on the back of flourishing automotive and construction industries. This speaks of hope for the metallurgical coal producers.

Demand Upsurge in Asian Countries: The increase in coal demand in Asian economies like China and India has been a key price driver since the end of the recession in 2009. We expect this trend to continue in the future mainly due to rising energy needs in India, China and South Korea. The current decline in demand in China will hurt, but the markets are going to improve gradually, if we go by the report from the International Energy Agency.

The two Asian countries also produce coal, but not enough to meet the growing demand in the region, resulting in a continuous need to import. These two countries also rely heavily on coal for electricity generation.

Japan is also importing large volumes of coal following the deactivation of its nuclear power plants. Given the rising demand from the fast-growing Asian economies, U.S. miners will find it attractive to export coal to these regions.

MLP and Diversification: Coal-based MLPs might stem some of the rot in the coal industry. SunCoke Energy Partners, L.P. (SXCP - Free Report) was formed from SunCoke Energy Inc. (SXC - Free Report) in 2013. CONSOL Energy (CNX - Free Report) followed the same path to form CNX Coal Resources LP CNXC. Both SunCoke Energy Partners and CNX Coal Resources LP are reporting in the green at a time when big players in the business like Peabody and Arch Coal have been forced to file for bankruptcy.

Coal companies are also resorting to diversification and are in the lookout for other sources of revenue besides coal. CONSOL Energy for the past couple of years has been expanding its natural gas portfolio and lowering its coal operation. Another coal miner, Alliance Resource Partners (ARLP - Free Report) , is also planning to invest $60 million to $70 million in 2016 to acquire oil and natural gas assets to broaden its revenue base.

To Sum Up

Among the coal miners, Natural Resource Partners (NRP - Free Report) and SunCoke Energy Partners,L.P. seem to be operating at a different level of performance compared to their struggling peers. These coal firms stand out with an unblemished earnings surprise record over the last four quarters. Their performances are particularly noteworthy when most of the big names are fighting for survival.

The importance of coal in the fuel source chain is far from over. For the aggressively growing and energy-hungry Asian economies, coal seems to be the most popular source of power generation in spite of inroads being made by renewables.

Large sections of the population in the developing nations of Asia and Africa have yet to access electricity. The lower cost of coal compared to other fuel sources and the stability coal-fired units provide to the grid’s performance make it a preferred choice in the emerging countries.

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